Deposit protection scheme edges closer to reality

Amid rumours the central bank is close to announcing a roadmap for the creation of Cambodia’s first national deposit insurance scheme, banking experts say the proposed mechanism would boost confidence in the Kingdom’s financial system and provide an extra layer of insulation for depositors in the event of a bank run or collapse.

A deposit insurance scheme (DIS) is designed to reimburse depositors when a bank fails or is unable to repay the money they have deposited. Where it exists, an effective DIS is a pillar of the financial safety net, protecting bank depositors while contributing to the stability of the country’s financial system.

Jisu Lim, an analyst for the Korea Deposit Insurance Corporation (KDIC), which protects more than $1 trillion of deposits in South Korea’s banking system, explains that while prudential measures such as minimum capital requirements and a liquidity coverage ratio aim to ensure that banks can weather shocks and cyclical downturns, deposit insurance assures bank depositors that, even if these measures fail, their deposits will be safe.

“If the central bank and the supervisory body perfectly regulated and managed the soundness of financial institutions, it would not be necessary to introduce a deposit insurance system – in theory,” she said. “However, history tells us that no prudential regulation system can prevent the failure of financial institutions.”

The International Monetary Fund’s (IMF) figures are telling, recording no less than 147 banking crises between 1970 and 2011, Jisu notes. The last major event, the 2008 Global Financial Crisis, underscored the importance of deposit insurance, which kicked in after prudential measures in the U.S. and other sophisticated financial markets failed to stop a cascade of bank failures.

“With the system in place, depositors trusted the financial system,” she said. “They did not withdraw their money from financial institutions. This helped secure financial stability.”

While more than 120 countries worldwide have implemented deposit insurance, Cambodia is the only country in ASEAN that does not have a DIS in place, though Myanmar’s fledgling deposit protection scheme is rudimentary and untested.

Jim Antos, a banking analyst at Mizuho Securities Asia, explains that deposit insurance schemes typically work by requiring banks to contribute a nominal percentage of their total deposits to an insurance fund. If a bank fails, the fund kicks in “to make sure that average families do not get their savings wiped out” – though most schemes put a cap on individual account coverage.

The National Bank of Cambodia (NBC) has been planning to implement a DSI since cleaning up the bank sector in the late 1990s. While there have been no major bank collapses since that time, the financial sector has been tested, most recently by a bank run that followed the contested 2013 national election results.

Recalling the incident, In Channy, chairman and group managing director of Acleda Bank, the Kingdom’s largest deposit-taking institution, said panicked customers “queued up for cash withdrawal at banks and ATMs, and emptied cash from the ATMs.”

While Channy supports the proposal to create a national deposit insurance scheme, he said the NBC was keeping a tight rein on the banking sector, and bank customers should feel assured that their savings are secure.

“In the event of a bank run, the capital guarantee and the fund reserves [held] at the National Bank of Cambodia can be used to protect the depositors,” he said. “On the other hand, the NBC can provide overdraft to banks, namely as a lender of last resort, so that banks faced with a bank run can use [these funds] to cool down their customers’ panic.”

Individual banks can also beef up their deposit protection with a banker’s blanket bond, he added, referring to a fidelity bond that protects a bank against fraudulent acts perpetrated by employees, as well as theft by non-employees.

This is particularly important in Cambodia, where embezzlement has been a far bigger risk to solvency than bank runs.

Given NBC’s strong existing prudential measures, Channy suggested the key value of an explicit DIS would be the confidence it would instil in Cambodia’s banking system, encouraging more people to deposit their savings in banks rather than under the proverbial mattress.

“It will raise the level of public confidence in banking and finance in Cambodia, and will increase the ratio of deposit to GDP [from 62 percent at the end of 2015] to at least one to one,” he said.

The NBC did not respond to a request for an interview, but industry sources say the central bank has stepped up consultations with experts and has commissioned feasibility studies for a DIS.

In July, NBC governor Chea Chanto met visiting U.S Treasury Department official Vilma Rosa Leon-York to discuss progress on the feasibility study. The closed-door meeting raised expectations, as Leon-York is a representative of the International

Association of Deposit Insurers (IADI), a Basel-based institution that is often the first stop for countries planning a DIS.

However, an IADI executive insisted that Cambodia had not approached the agency for advice, though it would certainly support the introduction of a DIS based on its widely adopted standards.

Instead, Cambodia has requested South Korean assistance, according to Jisu. In August, KDIC held a training seminar for the special working group that the NBC has formed to establish a deposit insurance system. A bilateral draft agreement on mutual
cooperation and exchange of information is expected by the end of the year.

While the NBC has kept its plan for a DIS under wraps, a scheme floated last year by Cambodia-based investment firm Mekong Strategic Partners (MSP) offered a viable framework.

Under its proposal, the Kingdom’s deposit insurance fund would be administered as a legally separate entity within the central bank and limited to a paybox function that activates in the event of a bank’s collapse. The scheme would be mandatory for all banks and deposit-taking microfinance institutions, and limited – initially at least – to covering only local currency deposits.

“The overwhelming reason for this is that Cambodia doesn’t have the capacity to insure dollar deposits, which make up over 90 percent of bank deposits here,” explains Stephen Higgins, managing partner at MSP.

The proposed scheme would impose a 0.1-percent levy on U.S dollar deposits, which Higgins expects would raise around $30 million per year, to guarantee deposits of up to 50 million riel (about $12,500) per bank customer. The nominal premium should have a minimal impact on banking profitability, though banks would likely lower their interest rates on U.S dollar savings to compensate.

“Experience suggests that banks will pass on these premiums in some way, shape or form, so ultimately it’s their customers who bear the cost,” Higgins said.

An added perk of riel-only coverage is that it would encourage people to deposit savings in local currency rather than in dollars, something the central bank has struggled to push.